20 years already? Alan Greenspan and the 'irrational exuberance' flop
MARKETWATCH 12:26 PM ET 12/5/2016
Former Fed head says he landed at that phrasing in a bathtub draft of the speech
Harken back to 1996 B.T. (before Twitter) and marvel at the speed at which a couple of potent words, buried in a rambling, heavy-on-history speech (https://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm) delivered by Federal Reserve Chairman Alan Greenspan on Dec. 5, 20 years ago today, made their mark on global financial markets in just a few hours.
In shorthand, Greenspan was warning that stocks had gotten too hot. Here's some of the context that surrounded the maybe-too-subtle alarm: "Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?"
Markets got the message, at least based on the knee-jerk reaction that sent stock futures and the dollar tumbling off- hours. But markets also felt empowered to ignore the powerful Fed head. If Greenspan intended, as he later admitted, to knock some wind out of stocks, his impact was not long-lasting. From there, stocks rallied for more than three years before the dot-com bubble finally burst in 2000.
Did Greenspan know the potential power of those words, which he has said he came up with while working on the speech in the bathtub? He sure did: "I was acutely aware of the fact that that particular phrase was put in that speech to spook the market," Greenspan said in a recent interview with the Wall Street Journal (http://www.wsj.com/articles/ irrational-exuberance-alan-greenspans-call-20-years-later-1480773602?mod=mktw).
How does Greenspan, 90, reflect on the speech and market reaction?
"If you rate me on my 'irrational exuberance' forecast, I get a C," he conceded. "But analytically, it was describing a process that I thought we had to be very concerned about."
And where's his concern bubbling now? The bond market. Notably its sharp rise in yields , a.k.a. interest rates.
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